14 Inventories and biological assets

Question 1

The use of LIFO is allowed under IAS 2.

Answer 1

The use of LIFO is prohibited under IAS 2.

Question 2

Scope The following items are excluded from the scope of the standard.

Answer 2

 Work in progress under long-term contracts (covered by IFRS 15 Revenue from contracts with customers  Financial instruments (ie shares, bonds)  Biological assets

Question 3

Inventories are assets: (3 points)

Answer 3

– Held for sale in the ordinary course of business; – In the process of production for such sale; or – In the form of materials or supplies to be consumed in the production process or in the rendering of services.

Question 4

Define Net realisable vale and fair value

Answer 4

 Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. (IAS 2)  Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

Question 5

Inventories can include any of the following

Answer 5

 Goods purchased and held for resale, eg goods held for sale by a retailer, or land and buildings held for resale  Finished goods produced  Work in progress being produced  Materials and supplies awaiting use in the production process (raw materials)

Question 6

Cost of inventories The cost of inventories will consist of all costs of:

Answer 6

 Purchase  Costs of conversion  Other costs incurred in bringing the inventories to their present location and condition

Question 7

Costs of purchase The standard lists the following as comprising the costs of purchase of inventories.

Answer 7

 Purchase price PLUS  Import duties and other taxes PLUS  Transport, handling and any other cost directly attributable to the acquisition of finished goods, services and materials LESS  Trade discounts, rebates and other similar amounts

Question 8

Costs of conversion Costs of conversion of inventories consist of two main parts

Answer 8

(a) Costs directly related to the units of production, eg direct materials, direct labour (b) Fixed and variable production overheads that are incurred in converting materials into finished goods, allocated on a systematic basis.

Question 9

Define Fixed production overheads & Variable production overhead

Answer 9

 Fixed production overheads are those indirect costs of production that remain relatively constant regardless of the volume of production, eg the cost of factory management and administration.  Variable production overheads are those indirect costs of production that vary directly, or nearly directly, with the volume of production, eg indirect materials and labour.

Question 10

The standard emphasises that fixed production overheads must be allocated to items of inventory on the basis of the normal capacity of the production facilities. This is an important point.

Answer 10

(a) Normal capacity is the expected achievable production based on the average over several periods/seasons, under normal circumstances. (b) The above figure should take account of the capacity lost through planned maintenance. (c) If it approximates to the normal level of activity then the actual level of production can be used. (d) Low production or idle plant will not result in a higher fixed overhead allocation to each unit. (e) Unallocated overheads must be recognised as an expense in the period in which they were incurred. (f) When production is abnormally high, the fixed production overhead allocated to each unit will be reduced, so avoiding inventories being stated at more than cost. (g) The allocation of variable production overheads to each unit is based on the actual use of production facilities.

Question 11

Other costs Any other costs should only be recognised if they are incurred in bringing the inventories to their present location and condition. The standard lists types of cost which would not be included in cost of inventories. Instead, they should be recognised as an expense in the period they are incurred.

Answer 11

(a) Abnormal amounts of wasted materials, labour or other production costs (b) Storage costs (except costs which are necessary in the production process before a further production stage) (c) Administrative overheads not incurred to bring inventories to their present location and conditions (d) Selling costs

Question 12

Techniques for the measurement of cost Two techniques are mentioned by the standard, both of which produce results which approximate to cost, and so both of which may be used for convenience.

Answer 12

(a) Standard costs are set up to take account of normal production values: amount of raw materials used, labour time etc. They are reviewed and revised on a regular basis. (b) Retail method: this is often used in the retail industry where there is a large turnover of inventory items, which nevertheless have similar profit margins. The only practical method of inventory valuation may be to take the total selling price of inventories and deduct an overall average profit margin, thus reducing the value to an approximation of cost. The percentage will take account of reduced price lines. Sometimes different percentages are applied on a department basis.

Question 13

Cost formulae Cost of inventories should be assigned by specific identification of their individual costs for:

Answer 13

(a) Items that are not ordinarily interchangeable (b) Goods or services produced and segregated for specific projects

Specific costs should be attributed to individual items of inventory when they are segregated for a specific project, but not where inventories consist of a large number of interchangeable (ie identical or very similar) items. In the latter case the rule is as specified below.

Question 14

Net realisable value (NRV) As a general rule assets should not be carried at amounts greater than those expected to be realised from their sale or use. In the case of inventories this amount could fall below cost when items are damaged or become obsolete, or where the costs to completion have increased in order to make the sale. In fact we can identify the principal situations in which NRV is likely to be less than cost, ie where there has been:

Answer 14

(a) An increase in costs or a fall in selling price (b) A physical deterioration in the condition of inventory (c) Obsolescence of products (d) A decision as part of the company’s marketing strategy to manufacture and sell products at a loss (e) Errors in production or purchasing

Question 15

A write down of inventories would normally take place on an item by item basis, but similar or related items may be grouped together. This grouping together is acceptable for, say, items in the same product line, but it is not acceptable to write down inventories based on a whole classification (eg finished goods) or a whole business. T/F

Answer 15

A write down of inventories would normally take place on an item by item basis, but similar or related items may be grouped together. This grouping together is acceptable for, say, items in the same product line, but it is not acceptable to write down inventories based on a whole classification (eg finished goods) or a whole business.

Question 16

The reasons why inventory is held must also be taken into account. Some inventory, for example, may be held to satisfy a firm contract and its NRV will therefore be the contract price. Any additional inventory of the same type held at the period end will, in contrast, be assessed according to general sales prices when NRV is estimated. Net realisable value must be reassessed at the end of each period and compared again with cost. If the NRV has risen for inventories held over the end of more than one period, then the previous write down must be reversed to the extent that the inventory is then valued at the lower of cost and the new NRV. This may be possible when selling prices have fallen in the past and then risen again. T/F

Answer 16

The reasons why inventory is held must also be taken into account. Some inventory, for example, may be held to satisfy a firm contract and its NRV will therefore be the contract price. Any additional inventory of the same type held at the period end will, in contrast, be assessed according to general sales prices when NRV is estimated. Net realisable value must be reassessed at the end of each period and compared again with cost. If the NRV has risen for inventories held over the end of more than one period, then the previous write down must be reversed to the extent that the inventory is then valued at the lower of cost and the new NRV. This may be possible when selling prices have fallen in the past and then risen again.

Question 17

Recognition as an expense The following treatment is required when inventories are sold.

Answer 17

(a) The carrying amount is recognised as an expense in the period in which the related revenue is recognised. (b) The amount of any write-down of inventories to NRV and all losses of inventories are recognised as an expense in the period the write-down or loss occurs. (c) The amount of any reversal of any write-down of inventories, arising from an increase in NRV, is recognised as a reduction in the amount of inventories recognised as an expense in the period in which the reversal occurs.

Question 18

Consistency – different cost formulas for inventories IAS 2 allows two cost formulas (FIFO or weighted average cost) for inventories that are ordinarily interchangeable or are not produced and segregated for specific projects. The issue is whether an entity may use different cost formulas for different types of inventories. True/ False

Answer 18

Consistency – different cost formulas for inventories IAS 2 allows two cost formulas (FIFO or weighted average cost) for inventories that are ordinarily interchangeable or are not produced and segregated for specific projects. The issue is whether an entity may use different cost formulas for different types of inventories.

Question 19

The main reason for developing a standard on agriculture was because there was great diversity in practice in accounting for agriculture at both a transnational and national level. It is quite difficult to apply traditional accounting methods to agricultural activities, which explains why agriculture is excluded from many IFRSs

Answer 19

(a) When and how do you account for the critical events associated with biological transformation (growth, procreation, production and degeneration), which alter the substance of biological assets? (b) Statement of financial position classification is made difficult by the variety and characteristics of the living assets of agriculture. (c) The nature of the management of agricultural activities also causes problems, particularly determination of the unit of measurement, ie whether biological assets are a perpetual group of assets or a number of limited life assets.

Question 20

Define the ff terms:
Agricultural activity
Agricultural produce
Biological assets
Biological transformation
group of biological asset
Harvest 
Fair value
Carrying amount

Answer 20

 Agricultural activity is the management by an entity of the biological transformation of biological assets for sale, into agricultural produce or into additional biological assets.  Agricultural produce is the harvested product of an entity’s biological assets.  Biological assets are living animals or plants.  Biological transformation compromises the processes of growth, degeneration, production and procreation that cause qualitative and quantitative changes in a biological asset.  A group of biological assets is an aggregation of similar living animals or plants.  Harvest is the detachment of produce from a biological asset or the cessation of a biological asset’s life processes.  Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. (IFRS 13)  Carrying amount is the amount at which an asset is recognised in the statement of financial position

Question 21

What are the key parts of the definition of agriculture

Answer 21

(a) Biological: agriculture relates to ‘life phenomena’, living animals and plants with an innate capacity of biological transformation which are dependent upon a combination of natural resources (sunlight, water, etc). (b) Transformation: agriculture involves physical transformation, whereby animals and plants undergo a change in biological quantity (fat cover, density, etc) and/or quantity (progeny, live weight etc) over time, which is measured and monitored (increasingly objectively) as part of management control. (c) Management: biological transformation is managed. (i) Conditions are stabilised or enhanced. (ii) The transparency of the relationship between inputs and outputs is determined by the degree of control (intensive versus extensive). (iii) It is different from exploitation through extraction, where no attempt is made to facilitate the transformation.(iv) Biological assets are managed in groups of plant or animal classes, using individual assets to ensure the sustainability of the group. (v) Sustainability of an agricultural activity is a function of quality and quantity. (d) Produce: agricultural produce is diverse and may require further processing before ultimate consumption.

Question 22

Scope The standard applies to the three elements that form part of, or result from, agricultural activity.

Answer 22

 Biological assets  Agricultural produce at the point of harvest  Government grants The standard does not apply to agricultural land or intangible assets related to agricultural activity (IAS 38). After harvest, IAS 2 is applied

Question 23

Biological assets We have seen the definition given above. Biological assets are the core income-producing assets of agricultural activities, held for their transformative capabilities. Biological transformation leads to various different outcomes:

Answer 23

Asset changes: – Growth: increase in quantity and or quality – Degeneration: decrease in quantity and/or quality
 Creation of new assets: – Production: producing separable non-living products – Procreation: producing separable living animal

Question 24

We can distinguish between the importance of these by saying that asset changes are critical to the flow of future economic benefits both in and beyond the current period, but the relative importance of new asset creation will depend on the purpose of the agricultural activity. The IAS distinguishes therefore between two broad categories of agricultural production system.

Answer 24

(a) Consumable: animals/plants themselves are harvested. (b) Bearer: animals/plants bear produce for harvest. A few further points are made: (a) Biological assets are usually managed in groups of animal or plant classes, with characteristics (eg male/female ratio) which allow sustainability in perpetuity. (b) Land often forms an integral part of the activity itself in pastoral and other land-based agricultural activities.

Question 25

Recognition of biological assets The recognition criteria are very similar to those for other assets, in that animals or plants should be recognised as assets in the following circumstances.

Answer 25

(a) The entity controls the asset as a result of past events. (b) It is probable that the future economic benefits associated with the asset will flow to the entity. (c) The fair value or cost of the asset to the entity can be measured reliably.

Question 26

Measurement of biological assets The IAS requires that at each year end all biological assets within the scope should be measured at fair value less estimated point-of-sale costs. The IAS allows an alternative method of valuation, if a fair value cannot be determined because marketdetermined prices or values are not available. Then the biological asset can be measured at cost less accumulated depreciation and impairment losses. This alternative basis is only allowed on initial recognition. The measurement basis used to depict the fair value of a biological asset will differ depending on the existence of an active market, market efficiency and the use made of the asset. In summary, it is felt that fair value, when compared to historical cost, has greater relevance, reliability, comparability and understandability as a measure of future economic benefits. t/f

Answer 26

Measurement of biological assets The IAS requires that at each year end all biological assets within the scope should be measured at fair value less estimated point-of-sale costs. The IAS allows an alternative method of valuation, if a fair value cannot be determined because marketdetermined prices or values are not available. Then the biological asset can be measured at cost less accumulated depreciation and impairment losses. This alternative basis is only allowed on initial recognition. The measurement basis used to depict the fair value of a biological asset will differ depending on the existence of an active market, market efficiency and the use made of the asset. In summary, it is felt that fair value, when compared to historical cost, has greater relevance, reliability, comparability and understandability as a measure of future economic benefits.

Question 27

Measuring fair value The standard states that the primary indicator of fair value should be net market value. This is reasonable as efficient markets exist for most biological assets in most locations and net market value is usually considered as providing the best evidence of fair value where an active market exists. Markets will generally differentiate between differing qualities and quantities. Market value is not generally predicated on management’s intended use, however, but recognises alternative uses. IFRS 13 requires the fair value of a biological asset to be determined by reference to the principal market for the asset. This may or may not be the most favourable market. An active and efficient market may not be available for a class of biological assets in a specific location, or there may be imperfections in the market. The standard goes into some detail about how fair value should be measured in such circumstances, but in summary the valuation techniques should be consistent with the objectives of measuring fair value and should attain an appropriate balance between relevance and reliability. TRUE/ FALSE

Answer 27

Measuring fair value The standard states that the primary indicator of fair value should be net market value. This is reasonable as efficient markets exist for most biological assets in most locations and net market value is usually considered as providing the best evidence of fair value where an active market exists. Markets will generally differentiate between differing qualities and quantities. Market value is not generally predicated on management’s intended use, however, but recognises alternative uses. IFRS 13 requires the fair value of a biological asset to be determined by reference to the principal market for the asset. This may or may not be the most favourable market. An active and efficient market may not be available for a class of biological assets in a specific location, or there may be imperfections in the market. The standard goes into some detail about how fair value should be measured in such circumstances, but in summary the valuation techniques should be consistent with the objectives of measuring fair value and should attain an appropriate balance between relevance and reliability.

Question 28

In the statement of financial position the biological assets must be shown at fair value less estimated point of sale costs, incorporating the consequences of all biological transformations. A gain or loss arising on initial recognition of a biological asset at fair value less estimated point of sale costs and from a change in fair value less estimated point of sale costs is included in profit or loss in the period in which it arises. T/F

Answer 28

In the statement of financial position the biological assets must be shown at fair value less estimated point of sale costs, incorporating the consequences of all biological transformations. A gain or loss arising on initial recognition of a biological asset at fair value less estimated point of sale costs and from a change in fair value less estimated point of sale costs is included in profit or loss in the period in which it arises

Question 29

Presentation and disclosure In the statement of financial position biological assets should be classified as a separate class of assets falling under neither current nor non-current classifications. This reflects the view of such assets as having an unlimited life on a collective basis; it is the total exposure of the entity to this type of asset that is important. Biological assets should also be sub-classified (either in the statement of financial position or as a note to the accounts):

Answer 29

(a) Class of animal or plant (b) Nature of activities (consumable or bearer) (c) Maturity or immaturity for intended purpose Where activities are consumable, the maturity criterion will be attainment of harvestable specifications, whereas in bearer activities, it will be attainment of sufficient maturity to sustain economic harvests.

Question 30

Agricultural produce This was defined in the key terms above. It is recognised at the point of harvest (eg detachment from the biological asset). Agricultural produce is either incapable of biological process or such processes remain dormant (eg stored grain). Recognition ends once the produce enters trading activities or production processes within integrated agribusinesses, although processing activities that are incidental to agricultural activities and that do not materially alter the form of the produce (eg drying or cleaning) are not counted as processing. Following harvest, the provisions of IAS 2 apply. t/f

Answer 30

Agricultural produce This was defined in the key terms above. It is recognised at the point of harvest (eg detachment from the biological asset). Agricultural produce is either incapable of biological process or such processes remain dormant (eg stored grain). Recognition ends once the produce enters trading activities or production processes within integrated agribusinesses, although processing activities that are incidental to agricultural activities and that do not materially alter the form of the produce (eg drying or cleaning) are not counted as processing. Following harvest, the provisions of IAS 2 apply.

Question 31

Measurement and presentation Following the treatment of biological assets above, the IAS states that agricultural produce should be measured at each year end at fair value less estimated point-of-sale costs, to the extent that it is sourced from an entity’s biological assets, which are also valued at fair value. This is logical when you consider that, until harvest, the agricultural produce was valued at fair value anyway as part of the biological asset. The change in the carrying amount of the agricultural produce held at year end should be recognised as income or expense in profit or loss. This will be rare as such produce is usually sold or processed within a short time, so that produce held over two reporting dates is being held for a specific management purpose and the consequences of that should be reflected in the current period. Agricultural produce that is harvested for trading or processing activities within integrated agricultural/ agribusiness operations should be measured at fair value at the date of harvest and this amount is deemed cost for application of IAS 2 to consequential inventories.
T/F

Answer 31

Measurement and presentation Following the treatment of biological assets above, the IAS states that agricultural produce should be measured at each year end at fair value less estimated point-of-sale costs, to the extent that it is sourced from an entity’s biological assets, which are also valued at fair value. This is logical when you consider that, until harvest, the agricultural produce was valued at fair value anyway as part of the biological asset. The change in the carrying amount of the agricultural produce held at year end should be recognised as income or expense in profit or loss. This will be rare as such produce is usually sold or processed within a short time, so that produce held over two reporting dates is being held for a specific management purpose and the consequences of that should be reflected in the current period. Agricultural produce that is harvested for trading or processing activities within integrated agricultural/ agribusiness operations should be measured at fair value at the date of harvest and this amount is deemed cost for application of IAS 2 to consequential inventories.
2

Question 32

What are the two categories in the agricultural production system

Answer 32

Consumable and bearer